No Need for Red Tape

Ever since the eruption of the economic crisis from 2008, the European Union has tried to stabilize its financial markets. Most recently, even the sound German real estate market has caught the regulators’ interest. According to new study from the Cologne Institute of Economic Research (IW) however, the outlined regulations might overshoot their target.

Before the 2008 economic crisis, most financial supervisory agencies applied the so-called microprudential approach: they controlled an individual financial institution’s solvency. But one lesson taken from the crisis was that a system-wide – a so called macroprudential – approach was additionally needed. Accordingly, the European Union and its member states have installed competent authorities and passed the required rules. Since financial markets are densely connected to real estate markets, residential property is now also subject to macroprudential supervision. However, sound indicators for the identification of instabilities in real estate markets are still missing.

Therefore, following the central result of the IW-Study, it needs to be assessed if a stricter regulation of the German real estate loans is really necessary. Although 50 percent of all German bank loans are invested in residential property, there is no indication of a price bubble: Aside from downtown locations of German major cities, overall property prices have increased only moderately up to now when compared to other countries. Moreover, there has been no massive increase in German banks’ loan supply, since banks are still cautious in granting credit.

The IW-study refers to Hongkong and Korea, two countries which applied macroprudential instruments to residential property: Both countries had to adjust their instruments several times, e.g. the loan-to-value-ratio, which determines how much own money the home buyer has to append to his or her bank loan for house purchase. The IW rejects similar experimentation in Germany: “There is no market failure in the German real estate financing, so there is no justification for a market intervention”, says the Institute’s financial market expert, Markus Demary. “Moreover, there is lack of sufficient political and scientific understanding on how the different macroprudential instruments interact with each other and on how they affect the economy.”